The Front End Of The Yield Curve Could Be In For A Dramatic Repricing

Editor's note: Below is an interview with David Keeble, head of fixed income strategy at Crédit Agricole. This Q&A went out to subscribers of our "10 Things You Need To Know Before The Opening Bell" newsletter on Friday morning. Sign up below to get the newsletter and more of these interviews in your inbox every day.

BUSINESS INSIDER: What is the most exciting trade out there right now, in your opinion?

DAVID KEEBLE: I'd sell 2-year and 3-year Treasuries. If you look at the spread between the fed funds rate and the 2-year U.S. Treasury, a few months before the Fed hikes rates, you typically see a spread of 175-240 basis points. Currently, that spread is around 32 basis points and I think that a Fed hike is about 18 months out. The 2-year has a lot of ground to cover over the next year or so. The correction won't come smoothly. We're expecting the 2-year to wake up one day and suddenly realize it's mispriced — just as the 10-year did last year when it jumped 150 basis points in a very short space of time.

BI: Which developments in global financial markets, if any, would you flag as most concerning for risk appetite?

DK: The Chinese liberalization of product and financial markets. The world's second largest economy is undergoing a revolution and it will be difficult to ensure it is perfectly smooth.

BI: Eurodollar shorts got a nice payoff on their record-large positions from yesterday's FOMC meeting. How do you think positioning will evolve between now and the next meeting?

DK: My guess is that investors will sell upticks and so we'll gradually build up short positions. However, adverse positioning acts like only a small anchor on a oil tanker. If the economy says that yields need to rise, prices can be marked lower and short positioning won't necessarily have a significant restraining influence.

BI: With the March FOMC meeting out of the way, what pieces of new information (e.g. economic data releases, price action in a given market over the next few days/weeks, etc.) do you think have the biggest potential to alter your outlook?

DK: On the economic front, I'm looking at the wage data in the payroll report. The hourly earnings spiked up last month perhaps due to a weather effect and Yellen dismissed the signaling content of that move. However, wage growth is the arbiter for the output gap, so I'm looking at it very closely. Otherwise, I afraid of the Ukrainian situation — as everyone is.

BI: What do you perceive to be the most misunderstood trend or event in or characteristic of today's markets?

DK: The appreciation of the euro, which seems to be ever in defiance of the best predictions. In my understanding, investors have shunned the zone for years but are flowing back on a consistent basis. This is even showing up in the Treasury's TICS data — Americans are buying foreign assets, and Europe would be my guess. I don't think there is much scope left because its been nearly two years of consistent peripheral sovereign spread improvement. As was pointed out to me the other day, Ireland's 10-year yield is 3.07%, compared to the U.S. at 2.78% — which would you sooner buy?